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Can This High-Yielding MLP Continue to Deliver?

Will this midstream MLP's aggressive growth strategy pay off?

Over the past decade or so, master limited partnerships, or MLPs, have proved to be some of the best investments you could have made, having outperformed the S&P500 in 11 out of the past 12 years. But with the benchmark MLP index lagging the S&P500 by more than 10% so far this year, and with many MLPs recently nearing 52-week highs, some investors are questioning whether this highly desirable sector can continue to match its historical returns.

The advantages of MLPsThe benefits of midstream MLPs, which are those that process and transport commodities like oil, natural gas, natural gas liquids, and refined product, are well known. The asset class benefits from a tax-advantaged corporate structure, as well as the rising demand for domestic oil and gas infrastructure. In recent years, MLPs, which offer an average yield of around 6%, have attracted a tremendous amount of investor attention and capital inflows into the sector have soared.

One of the most important criteria for evaluating an MLP's strength is the sustainability of its distribution. One name I especially like is Enterprise Products Partners(NYSE: EPD). While its yield, currently at 4.6%, is below the sector average, its prospects for growth are strong. The company has increased its distribution for 32 straight quarters and boasts a solid distribution coverage ratio (an indicator of the sustainability of its payouts) of around 1.4 times as of the end of June.

With that said, let's take a look at what's in store for Enterprise.

Can this monster MLP continue to deliver monster growth?Enterprise Products Partners is a behemoth in the MLP space. It's the largest publicly traded energy partnership in the U.S. with an enterprise value of around $62 billion. The company boasts 50,700 miles of pipeline to transport natural gas, crude oil, natural gas liquids, as well as refined products and petrochemicals. It also has 190 million barrels of storage capacity for crude oil, natural gas, and refined products, as well as 14 billions of cubic feet of natural gas storage capacity.

Over the past 15 years, Enterprise has been a tremendous performer, having returned over 500%, as compared to the S&P500's measly 30%. Given the company's aggressive plans for growth, this sort of performance should continue for the foreseeable future.

Currently, Enterprise has a whopping $7.5 billion of growth projects under construction, which include new infrastructure to transport natural gas, natural gas liquids, and crude oil to support the development of key plays like the Eagle Ford, the Permian Basin, and the Marcellus and Utica shales of Pennsylvania.

Many of these projects, such as the Texas Express NGL Pipeline and the Front Range NGL Pipeline, are joint ventures with other companies that have already secured 10-year, ship-or-pay agreements. The benefits of such projects will accrue over many years and should continue to support increases in the company's distribution, which rose 5% year over year for the most recent quarter.

Financial flexibilityOver the past few years, Enterprise has adopted a better and more simplified organizational structure. Back in November of 2010, it merged with Enterprise GP Holdings LP, and in September of last year with Duncan Energy Partners LP. Both mergers helped the company reduce capital costs by eliminating incentive distribution rights, which are -- as the name suggests -- rights that incent the general partner to increase cash distributions over time by enabling it to receive rising percentages of available cash flow.

As such, Enterprise enjoys one of the lowest costs of equity capital in its peer group, along with Genesis Energy(NYSE: GEL), Western Gas Partners, Magellan Midstream Partners, and Sunoco Logistics Partners -- a crucial advantage in an industry that relies so heavily on the capital markets for financing. Speaking of financing, Enterprise has funded its growth strategy primarily through debt and equity issuance, retained distributable cash flow, and proceeds from the sale of $2.2 billion in low-return, non-core assets.

One of the best business models aroundFinancial strength and a diversified asset base are both important advantages. But perhaps the thing I like most about Enterprise, and midstream MLPs in general, is their "toll-road" type of business model. Because they get to charge fees based on volume, for which they have very long-term contracts in place, midstream MLPs tend to have very consistent revenues and are relatively resilient to fluctuations in commodity prices.

For instance, companies like Enterprise, Kinder Morgan Energy Partners(NYSE: KMP), Plains All American(NYSE: PAA), and Oneok Partners(NYSE: OKS) all derive the bulk of their revenues from fee-based contracted assets. In the case of Enterprise, more than 70% of the company's revenues are derived from fee-based contracts, with that share expected to rise over the next few years. Last year, 73% of the company's revenues were derived from fee-based assets. This year, that percentage is projected to come in at 77%, and next year, 80%.

With a large, high-quality, and diversified portfolio of assets, as well as the tremendous cash flow stability afforded by its high and rising percentage of fee-based contracted assets, Enterprise's future looks very bright. As the company continues to bring new projects online and expand its already massive asset base, earnings and distributions should continue to rise as they have in the past.

As you can see, MLPs play a necessary role in our booming domestic energy market. But they're not the only game in town. Energy services and equipment companies are a crucial part of the picture, as well. In fact, one oil and gas equipment provider is the top pick this year among our analysts here at the Fool. You can read more about this company and why it's ready to soar in The Motley Fool's special free report: "The Only Energy Stock You'll Ever Need." Don't miss out on this limited-time opportunity to discover the name of this company. Click here to access your report -- it's totally free.

Author

Arjun is a value-oriented investor focusing primarily on the oil and gas sector, with an emphasis on E&Ps and integrated majors. He also occasionally writes about the US housing market and China’s economy.